Column: Hawkish on inflation, softish on growth

SummaryGovernor Subbarao has dutifully lived up to the market consensus of delivering the 10th rate hike in 15 months—a 25-basis-point rise in the repo and reverse repo rates, bringing them to 7.5% and 6.5%, respectively.

Governor Subbarao has dutifully lived up to the market consensus of delivering the 10th rate hike in 15 months—a 25-basis-point rise in the repo and reverse repo rates, bringing them to 7.5% and 6.5%, respectively. The cash reserve ratio (CRR) remains constant at 6%.

But the decision was not really as straightforward as it may appear. In many ways, this review by the Reserve Bank of India (RBI) was close to the sharpest edge of the classical central banker’s dilemma, whether to cut rates and boost growth or raise them to contain inflation. In a rather unusual show of transparency, the Chief Economic Advisor himself had commented publicly a few days ago advising RBI to take into account slumping industrial production and hold back on raising rates. Probably he was just giving an opinion, not really trying to influence RBI, for if it was the latter the choice of communication channel could hardly have been more counter-productive. In any event, the latest inflation figure, northwards of 9%, is away from RBI’s “comfort zone”—and it better be—while the slump in the April’s year-on-year index of industrial production (IIP) to around 6% is equally lacking in comfort for the growth advocates.

The governor chose inflation as the bigger evil. The choice is well grounded in both economic theory and central bank wisdom. It is difficult to argue with RBI’s view of things—the relative importance of the two threats—explained in the quarterly review.

How much dent a 25-basis-point rise is going to have on inflation immediately is, and will remain, an open question. The rain gods are being invoked to take care of not just inflation but of growth as well. In any case, the direction of the move is beyond question. It signals RBI’s hawkish-on-inflation stance and helps fixing the inflationary expectations at a lower level. It probably also suggests that the tightening phase of monetary policy that the country has entered since October 2009 still has a few notches to go. Indeed, the repo rate stood at a full 9% on the eve of the Lehman collapse.

That said, things do not look very bright just now on the investment and growth side for India. The clouds on the international horizon grow darker. At home, projects are being held back or shelved indefinitely. Perhaps the most telling indicator is an unlikely source—the foreign direct investment (FDI) inflow data. FDI in India declined by over